Mastering the AIFMD challenge: a survey - Is the passport worth the pain? | Whitepaper
Few pieces of EU legislation have attracted as much debate, discussion and even passion as the Alternative Investment Managers Directive (AIFMD) nor been the subject of such intense debate. And that debate has been not only technical and industry related but at times intensely political.
The drafting process itself was complex with the European Commission, the Council and the Parliament all working on and producing drafts in parallel requiring not least a significant effort to reconcile and follow successive proposals.
No fewer than 1,669 amendments were moved by members of the European parliament alone, a record in its own right. In the end discussion was necessary at two successive EU summits before a final position sufficiently acceptable to all to get onto the statute books was worked out in Brussels in late 2010.
Nor, it is true, did any piece of legislation come into being at such an inauspicious conjuncture of circumstances. The Commission had launched Expert Groups and Consultations as far back as 2006 on Alternative Investment Funds, inspired mostly by the manifest success of the UCITS product and the label and quality that have been achieved over years by that Directive.
But the catalyst for the Directive in its final form was certainly the events of 2008 and the near melt down that Financial Markets suffered in those tortuous months and the after-shocks that are still reverberating around the system with the jury still out as to the precise point in the crisis cycle that has been reached.
So to an already complex reflection were added the ingredients of bewilderment, uncertainty, preconception and possibly even fear in arriving at an instrument that is intended to set out the way forward for key parts of the Investment Fund industry, certainly within the Internal Market but with inevitable repercussions also on the world stage. The final impetus was no doubt given by the G20 meeting of April 2010.
For although strictly speaking the Directive only has legal effect within the confines of the European Union, by virtue of the sector it sets out to regulate, it reaches potentially far beyond Europe. The way it is perceived, the interactions with other jurisdictions cannot fail to have implications for the industry as a whole.
More importantly, given the structure and the prevalent domiciles of the Alternatives industry, it will attract comment, reflection and attention far beyond the narrow shores of Europe. Taken in conjunction with the parallel but separate evolution of the US Dodd-Frank initiative it is likely to change the tissue of the Alternatives sector in a lasting manner.
Not the least, the Directive will have a significant role to play in the formulation of Cross Border Distribution at a time when some economists are beginning to question the tenets of Globalisation, tracing interesting parallels to the Gold Standard, and looking at the whole issue of capital flows in light of more recent events in the Eurozone and its sovereign debt.
And the Directive is ground breaking in another respect. This is already to be found in its title. It is a “Managers” Directive. This is probably the first instance where far-reaching impacts and even reform of products is achieved indirectly, by looking first to source, and thereafter regulating products by inference and implication; in setting out the Managers’ obligations, the way they are to discharge those obligations influences the products themselves.
So a piece of legislation with far-reaching consequences. But also a delicate balancing act. For the aim of the Directive, having departed somewhat from the more prosaic reflection with which it started, is nothing less than to enhance investor protection and manage or alleviate systemic risk throughout the financial system as far as all Alternative Fund Products are concerned.
For Europe needs the yields of Alternative Investment Products.
Against the background of the difficulties of the Banking Sector, and now the debacle around European sovereign debt, there is a greater and potentially even less manageable crisis looming, and that is the retirement “time bomb”. For if debt to GDP ratios are today discouraging, if the pension shortfall is taken into consideration on a Net Present Value basis, those Debt to GDP rations soar to around 300% for many European countries. With a generally low level of savings coverage, significant investment returns on retirement savings are essential if Europe is to avoid the nightmare of not only an ageing population but an increasingly impoverished one. And when one speaks of significant returns one speaks inevitably of Alternatives. So that is the paradigm, Europe needs the Industry it has set out to regulate, and potentially needs it to an extent it never imagined. And in return the Directive potentially facilitates access to greater pools of investible income via the Passport. The key question is does the Directive get that balance, the delicate balance, between inducement and sanction right?
The scope of AIFMD is at the same time simple and complex. Broadly speaking if a Manager is either situated within the EU, manages a product that is domiciled in the EU, or distributes a product to investors in the EU, then the Directive will apply to a greater or lesser extent.
Moreover, there was already significant debate on definition in the drafting of the Directive, debate as to what constitutes an Alternative Investment. This debate is likely to carry over into the drafting of National Laws and indeed to a certain extent this can already be seen.
At the end of the day it proved simpler to define what an Alternative Investment is not than what it is. Clearly it cannot be a UCITS for these are already regulated by the UCITS Directives, of which the fifth re-iteration is currently under consideration. Therefore Alternative Investment Funds were defined as everything that is not a UCITS.
And thereby an additional complexity saw the light of day, because within the realm of UCI’s many products that are more akin to UCITS than to, for example Hedge Funds, fall within that definition. This is the case for many Luxembourg Part II Funds and more importantly SIFs.
And these reflections, around the level of assets under management, around the number of shareholders, and around the purpose for which some investment funds have been put in place are especially relevant for the thriving SIF sector in Luxembourg, and require the full co-operation and input from all the actors on the local scene to see legislation enacted intelligently and with that open pragmatism that has created the environment in which the sector has thrived in the first place.
It should not be forgotten that within the Directive, ESMA is charged with organising “Peer Group” reviews as to the manner in which “Competent Authorities” discharge their responsibilities under the Directive.
Undoubtedly one of the greatest challenges for Industry and Regulator alike will be in finding the right framework for these non-Alternative Investment Funds that fall de facto within the scope of the AIFMD.
The Directive draws much of its inspiration from the Hedge Fund sector. It is already a stretch to apply some of these very valid concepts to the world of Real Estate and Private Equity. Moving beyond to funds that are more akin to UCITS than Alternatives in their Investment policies and purposes is an additional bridge to cross. It is to be hoped that it is not a “Bridge too far” for these structures as well have a significant role to play in the overall sphere of wealth creation and retention in Europe.
It was to seek to see more clearly, if not the answers to the questions raised here, and to others that have arisen throughout the protracted consultation process that has brought AIFMD to the point where it will shortly begin the process of transcription into National Law, then at least to where the market stands in its reflections on these key points, that the idea for this Survey originated.
For what better way to evaluate the thinking and the preparedness of the market to meet the challenges ahead than to ask the market itself.
In addition, since the Survey results reflect the thoughts of the market, its progress to date, its aspirations and its apprehensions, they serve as well as the raw material for a benchmarking exercise that readers may use to evaluate for themselves where they stand versus their peers and versus the collective in tackling the issues that the Directive will raise for them.
This survey was conducted in a condensed space of time, and reached out to a maximum of market participants deemed to have an interest in the Alternatives sector, an existing business in Luxembourg, and likely to be impacted to at least some extent by AIFMD. This approach was adopted to ensure topicality and relevance.
The whole process surrounding AIFMD, as has already been remarked, was protracted; there have been many iterations, and involvement has gone through successive peaks and troughs. Anecdotally it has been noted that while the general level of awareness remains high, the degree of involvement or indeed the sense of immediacy has not remained constant. It was therefore a prime consideration to fix for the benefit of all, where the industry, as defined by the survey, stands at a given point in time, and that as recent as possible.
The Survey was structured so as to allow data to be collected both at Industry level, with responses reflecting the overall readiness and positioning of the “Luxembourg” market to the challenge, and at sub-set level, by asset Class or by Market participant type, to seek to identify points of divergence and convergence across multiple disciplines. Finally it also sets out to address the difficult question as to how AIFMD will impact those non-Alternative Funds as described above that fall within its ambit.
The response of the “market” to the Survey was hugely encouraging and it can be estimated to be statistically representative of the current “State of Play”.
We should like to thank all those who participated in the exercise; they have contributed to a significant piece of market research that will allow us to set a benchmark, and potentially to reassess at a future point both progress to date, changes in opinion and intent, and geographic differences as we extend our research to other Fund centres and domiciles.
Is the regulation worth the effort? Yes we believe so.
We trust you will enjoy reading this survey. Should you like to discuss any of the points raised or the broader context of AIFMD please do not hesitate to contact us.
Directeur | ERS-Regulatory Consulting
Partner | ERS-Regulatory Consulting
The survey results
The survey results have been grouped around certain key-themes. These are:
- Who Participated in the Survey
- Information – Concern and Cost
- Opportunity Versus Effort
- A Repeat of UCITS
In each section the results have been drilled down into greater granularity, and where there are significant divergences either between market participants, Management Companies versus Third party Administrators for example, or between Asset Class, Private Equity versus Hedge Fund... these diverges are shown and analysed.
It should be noted that the questions for the most part were not mutually exclusive. Respondents could consider themselves for example as both Administrators and Management Company, or could have a book of business covering both UCITS like SIFs and Real Estate Funds.
It is also interesting to note that in some key areas there is a high level of inconsistency, even contradiction in the responses given. This is most notable in the questions around distribution. This was sufficiently apparent to justify a special paragraph highlighting these inconsistencies and exploring some of the potential reasons for such inconsistencies.
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